Liquidity Ratios
1.Debtors Turnover Ratio
Debtors constitute an important constituent of current asset and therefore, the quality of debtors to a great extent determines a firm's liquidity.
The Debtors Turnover Ratio=
Credit Sales/Avarage Accounts Receivable
The Account Receivable includes Trade debtors and Bills Receivable
Suppose,credit sales = 80000
Avarage Account Receivable= 22500
=80000/22500
Debtors Turnover Ratio= 3.56
Avarage Accounts Receivable= op bal+cl bal/2
Importance of Ratio=
1. The higher ratio indicate that debts are being collected more promptly.
2. for measuring the efficiency, it is necessary to set up a standard ratio and then a ratio lower than the standard will indicate inefficiency.
3. The ratio helps in Cash Budgeting since the flow of cash from customers can be worked out on the basis of sales.
2. Debts Collection Period Ratio
The ratio indicates the extent to which the debts have been collected in time. It gives the average debts collection period. The ratio is very helpful to the lenders because it explains to them whether their borrowers are collecting money within a reasonable time and increase in the period will result in greater blockage of funds in debtors
Eg.
Credit sales - 12000
Debtors - 1000
Bills Receivable- 1000
Debtors Turnover Ratio= credit Sales/ Accounts Receivable
12000/2000= 6 times
Debt Collection Period= Months in a Year/ Debtors Turnover
12/6= 2 months
Importance of Ratio
1. Debtors collection period measures the quality of debtors.
2. A shorter collection period implies prompt payment by debtors.It reduces the chances of bad debts.
3. A longer collection period implies too liberal and inefficient credit collection performance.
4. Debt collection period should be neither too liberal nor too restrictive.
It is difficult to provide a standard collection period of debtors. It depends upon the nature of industry, seasonal character of business and credit policies of the firm. In general, the amount of receivables should not exceed 3-4 months credit sales.
.jpg)